Risks of rare economic disasters can have large impact on asset prices. At the same time, difficulty in inference regarding both the likelihood and severity of disasters as well as agency problems can effectively lead to significant disagreements among investors about disaster risk. We show that such disagreements generate strong risk sharing motives, such that just a small amount of optimists in the economy can significantly reduce the disaster risk premium. Our model highlights the "latent" nature of disaster risk: the disaster risk premium will likely be low and smooth during normal times, but can increase dramatically when the risk sharing capacity of the optimists is reduced, for example, following a disaster. The model also helps reconcile the difference in the amount of disaster risk implied by financial markets and international macro data, and provides caution to the approach of extracting disaster probabilities from asset prices, which can disproportionately reflect the beliefs of a small group of optimists. Finally, our model predicts an inverse U-shaped relation between the equity premium and the size of the disaster insurance market.

It is known that the imposition of orbifold boundary conditions on background scalar field can give rise to a non-trivial vacuum expectation value (VEV) along extra dimensions, which in turn generates fat branes and associated unconventional Kaluza-Klein (KK) towers of fermions. We study the structure of these KK towers in the limit of one large extra dimension and show that normalizable (bound) states of massless and massive fermions can exist at both orbifold fixed points. Closer look however indicates that orbifold boundary conditions act to suppress at least half of bound KK modes, while periodic boundary conditions tend to drive high-lying modes to conventional structure. By investigating the scattering of fermions on branes, we analytically compute masses and wavefunctions of KK spectra in the presence of these boundary conditions up to one-loop level. Implication of KK-number non-conservation couplings on the Coulomb potential is also examined.

Although the threat of rare economic disasters can have large effect on asset prices, difficulty in inference regarding both their likelihood and severity provides the potential for disagreements among investors. Such disagreements lead investors to insure each other against the types of disasters each one fears the most. Due to the highly nonlinear relationship between consumption losses in a disaster and the risk premium, a small amount of risk sharing can significantly attenuate the effect that disaster risk has on the equity premium. We characterize the sensitivity of risk premium to wealth distribution analytically. Our model shows that time variation in the wealth distribution and the amount of disagreement across agents can both lead to significant variation in disaster risk premium. It also highlights the conditions under which disaster risk premium will be large, namely when disagreement across agents is small or when the wealth distribution is highly concentrated in agents fearful of disasters. Finally, the model predicts an inverse U-shaped relationship between the equity premium and the size of the disaster insurance market.